A recent report from the Federal Reserve Bank of New York is raising eyebrows after it found that American household credit card debt reached an all-time high of $1.21 trillion at the end of last year. While a concerning development, there is no evidence that proposals like Senators Bernie Sanders (I-VT) and Josh Hawley’s (R-MO) credit card interest rate cap of 10 percent would provide consumers with the relief that is intended. On the contrary, such artificial rate caps are a form of distortionary price control that research has routinely demonstrated reduces borrowers’ access to credit. For this reason, Congress should reject this proposal and others like it.
Early last month, Sanders and Hawley announced legislation that would cap credit card interest rates at 10 percent, arguing that such a cap was necessary to prevent card issuers from participating in “extortion and loan sharking.” To support their case, they note working Americans are “drowning” in credit card debt and that the average credit card interest rate is 28.6 percent. However, the senators neglect to mention that card issuers set rates to reflect the level of risk they undertake to provide a given service. The ability to adjust rates is fundamental to their ability to insulate themselves from that risk and cover the costs associated with processing transactions. Artificial price controls tie card issuers’ hands.
To recoup costs, card issuers will be forced to take more unpopular actions. Such actions include raising annual fees and maintenance fees that apply to all cardholders regardless of risk, discontinuing card rewards programs, and even reducing access to lines of credit, which will have the practical effect of punishing low-income Americans who are more likely to be high-risk borrowers that rely on credit for short-term financing.
This is exactly what happened following the passage of the Durbin Amendment in 2010, which directed the Federal Reserve to regulate and cap debit card interchange fees. Card issuers responded by reducing the availability of free checking accounts, hiking minimum balance requirements, and eliminating popular debit card benefits and rewards, such as cashback and discounts. In fact, a study by Northwestern’s Kellogg School of Management found that the Durbin amendment’s impact on debit card rewards was so significant that there was a “30 percent decline in debit-card payment volumes and a corresponding increase in credit-card payment volumes.”
Consumers also received little of the promised cost savings, with a Federal Reserve Bank of Richmond study later finding that just two percent of merchants lowered prices following the Amendment’s passage. There is no reason to think things would be any different with a similar cap on credit card transaction fees.
Perhaps most troubling, the Durbin Amendment caused some Americans to lose access to the banking system altogether. For instance, a study by the International Center for Law & Economics found that the combination of fee increases and loss of free checking accounts likely “contributed to an increase in the unbanked population of approximately 1 million people.” There is no reason to think imposing a similar regulatory scheme on the credit card market would achieve better results. Instead, establishing a 10 percent credit card interest rate cap will most likely force card issuers to, at a minimum, tighten credit requirements and deny service to high-risk borrowers who will have little choice but to turn to alternative, sometimes far more dangerous, sources of credit.
A good example of the negative impact of rate caps on borrowers can also be observed at the state level. After Illinois passed a 36 percent annual percentage rate cap in 2021, the number of loans to subprime borrowers declined, and the size of loans increased. The results of other studies are similarly troubling. For instance, when Oregon imposed a similar rate cap, borrowing fell in the state, and the “overall financial condition of the Oregon households” declined.
It remains to be seen whether Sanders and Hawley’s credit card interest rate cap proposal will become a reality. However, there can be little doubt that, if successful, it would produce catastrophic consequences for the credit card market that make it more difficult for consumers to obtain credit. Credit cards remain remarkably popular with consumers due to their easy accessibility, convenience, and highly coveted reward features.
While consumers should certainly guard against taking on large amounts of debt, it would be a mistake for the government to impose arbitrary limits on what prices private businesses may charge customers to complete transactions. Credit cards serve a valuable market function by making credit more readily available to Americans of all income levels. Lawmakers should not lose sight of this fact.
Nate Scherer was the Director of Finance Policy at the American Consumer Institute, a nonprofit education and research organization. For more information about the Institute, follow us on X @ConsumerPal.